For the first time Mesa discussed its proposed sale of its joint venture with Shenzhen Airlines, Kunpeng Airlines, as reported by Regional Aviation News six weeks ago, with investors, saying it has reached a letter of intent, cut in June, to sell its share of the airline owing to increasing losses and the fact it was notified that Kunpeng will no longer need its aircraft beyond the five already operating out of Xian. Related Story KunPeng recently ordered Embraer’s ERJ 190 Related Story Mesa said it is likely losses for the fledgling carrier will continue into the foreseeable future.
"Clearly it's not the big hit we hoped for," Mesa Air Group CEO Jonathan Ornstein told investors last week. “Their fuel is more controlled than here and we relied on our partners to have a better understanding of market and there is not the level of sophistication there in terms of distribution. I also think it has been difficult managing the operation from such a distance.”
As a result of the Letter of Intent, the company wrote down its investment in Kunpeng by approximately $1.3 million. This loss reflects the $4.8 million in gross receivables from Kunpeng, less the company's investment at June 30, 2008 of $5.8 million and estimated transaction costs of $300,000. Kunpeng Airlines will continue to lease the five CRJ-200 regional jets currently flying in China, said CEO Jonathan Ornstein, who indicated the only reason Mesa went into the deal was to have a place for the 50-seat regional jets no longer needed in its domestic market. KunPeng has yet to reach its first anniversary. Total sublease revenue for the quarter ended June 30, 2008 was $1.3 million.
Ornstein noted that Mesa does have a revenue guarantee and is responsible for only a small portion of losses. “We decided to take a shot at it and the numbers have not been as we had hoped for,” he said. “Frankly, the cash right now is valuable to us.”
He noted air fares are good, but said passenger traffic has not lived up to expectations and MAG no longer has the time to continue investing in a long-term payoff. He alluded to the debt repayments coming in late January which will exacerbate the company’s need to increase cash. At the end of its third quarter on June 30, it only had $60 million in cash, only $46 million of which is unrestricted, a dramatic decline from the $158.1 million in cash ($55.3 million unrestricted) at the end of its second quarter in March.
MAG is facing paying off bondholders, its dispute with Delta over the termination of Freedom’s Delta Connection operations and stocks trading below the point required for NASDAQ listing. Ornstein said the company does not have the ability to pay bonds in cash but may trade the bonds for stock.
Delta accounted for approximately 18.9 percent of the company's total passenger revenue in the third quarter. Following the court's ruling granting Mesa a temporary halt to the termination of Freedom’s ERJ 145 service, Mesa and Delta reached an interim financial understanding (subject to the mutual reservation of rights) in which Delta will reimburse the company for certain costs – lease payments, insurance, maintenance, pilots/flight attendants wage minimums and a normal profit – and the majority of the ERJ-145 aircraft will remain out of service until October 2008.
The depth of problems between Mesa and Delta was revealed in the company’s 10Q which said that, “on August 6, Mesa filed a complaint against Delta Air Lines seeking the return of seven aircraft engines that Mesa said Delta improperly retained following the termination of an engine maintenance memorandum of understanding,” said the company in its filing. “Delta claims its retention of these engines is justified as a means to secure recovery of certain disputed amounts totaling approximately $4.5 million related to the memorandum of understanding. Mesa's action, filed in the United States District Court, seeks the immediate return of all engines currently in Delta's possession and/or control. Failure to secure possession of these engines could have a material adverse impact on continuing operations in the event the company is unable to obtain suitable replacements in a timely manner. An adverse ruling could likewise result in a material negative impact of our financial condition or results of operations. The company believes it is not obligated to make the disputed payment. In the event the disputed payment is found to be required, the company will incur additional maintenance expenses.”
The company is also currently involved in a dispute with another vendor in connection with an engine maintenance agreement regarding approximately $1.8 million in what Mesa calls unauthorized repairs.
In another move with an unidentified code share partner, Mesa executed an amendment to their agreement which resolved certain commercial issues between the parties. As a result, the company recorded a charge of approximately $3 million dollars during the quarter. In accordance with the amendment, Mesa entered into a deferred payment plan, under which if Mesa fails to make any of the payments the code share partner may reduce certain aircraft in operation.

go! Losses
Meanwhile, its Hawaiian subsidiary, go!, lost $7.4 million during the company’s third quarter ended June 30, double the $3.7 million in the year-ago period. Local Hawaiian news reports indicated that Hawaiian Airlines has benefited most from Aloha’s shut down saying Hawaiian Airlines earned $1.8 million profit during the second quarter compared to go!’s losses.
The Hawaiian carrier posted $22.9 million loss since the beginning of MAG’s fiscal year nine months ago, up $9.5 million from the year-ago period. Operating revenues jumped 151 percent to $15.6 million compared to $6.2 million in the year-ago period but fuel prices overcame those gains as operating expenses rose 131.9 percent to $23 million versus $9.9 million in the year-ago quarter.
However, Ornstein said falling fuel prices and rising fares have improved go!’s situation. "If you add those numbers up, you can draw some conclusions as to why we continue to move forward and are committed to the go! operation," he said. Mesa's go! increased capacity to meet the market's decrease in supply resulting from the Aloha liquidation by adding two CRJ 200s, pushing Available Seat Miles (ASMs) up 61 percent from the prior quarter.
Investors asked Ornstein, with 18 of his 26 years in the airline business at Mesa, to discuss whether or not the regional sector will be worthy of investment. “With fuel reaching $4.50 per gallon, no one can make sense of 50 seater aircraft. Going forward you’ll see the swap out of CRJ 700s for CRJ 200s but we will have to wait for a general industry recovery before we see any significant amount of growth opportunity. The losses today, compared to 911, have been far more damaging and we have to bear through it best we can. Fortunately, United and US Airways have been very supportive, and we are now looking at ways we can be of assistance in terms of fleet flexibility.”

Third Quarter Results
In the wake of its peers reporting good second quarter results, Mesa Air Group, Inc. reported third quarter after tax income of $1.8 million from continuing operations on operating revenues of $353.9 million. Total operating revenues for the third quarter of 2008 increased $13.5 million, or 4.0 percent from the same quarter in 2007. The net income of $1.8 million, or $0.07 per diluted share, compares to a net gain from continuing operations of $4.4 million, or $0.15 per diluted share for the same period of fiscal 2007.
Pro forma net loss for the quarter was $2.5 million or $0.09 per diluted share. Pro forma net adjustments on an after-tax basis were the following: a $4.5 million gain on extinguishment of debt which includes $3.6 million gain on the sale of 14 Beechcraft 1900Ds to the lien-holder and a $0.9 million gain on convertible debt, $1.3 million gain from a settlement made with Big Sky on the return of aircraft, a $1.2 million gain on securities, a $0.8 million gain on investments, and a $0.2 million gain on disposal of assets. Pro Forma losses included: a $1.9 million code share partner settlement, go! legal expenses of $0.8 million, $0.7 million costs associated with the Chinese joint-venture and $0.3 million lease return costs.
Total Available Seat Miles (ASMs) for the third quarter of fiscal 2008 decreased 10.9 percent from the third quarter of 2007 owing to a drop in the number of aircraft flown from 199, as of June 30, 2007 to 161 as of June 30, 2008. At June 30, Mesa's operating fleet was comprised of 80 50-seat regional jets, 38 86-seat regional jets, seven 76-seat regional jets, 20 66-seat regional jets and 16 37-seat turboprops. Under the US Airways contract, the company operated 51 regional jets and six turboprops. Under the United contract, the company operated 46 regional jets and 10 turboprops. Mesa operated 41 regional jets for Delta. The company also flew seven regional jets at go!
During the quarter Mesa returned 14 of its 34 Beechcraft 1900D aircraft to Raytheon Aircraft Company. Raytheon accepted the return of the aircraft and the subleases associated with four of them. One result of the agreement was the elimination of approximately $28 million of long-term debt associated with the financing of such aircraft from the company's balance sheet. The net gain in the quarter from this transaction was $5.8 million. Air Midwest, which operated the aircraft, ceased all operations on June 30th.